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Investors have taken note of the Federal Reserve’s guidance and priced in both higher inflation and a robust rebound in economic activity later this year. REUTERS/Chris Wattie/File Photo/File PhotoChris Wattie/Reuters

Signs that inflation is making a comeback are unsettling big investors.

Past periods of high inflation have weighed heavily on real returns from stocks and bonds, which have flourished over the past decade when inflationary pressures have generally remained muted.

But inflation forecasts are now rising following massive increases in government spending and the torrent of liquidity unleashed by central banks in response to the COVID-19 pandemic.

Global asset managers are now facing a barrage of questions from clients over the risks of inflation and are rushing to shore up portfolios from inflationary risks, fearing that a resurgence threatens to spoil the party again for investors.

“Inflation is an escalating concern among institutional investors,” said Michael John Lytle, chief executive officer of Tabula Investment Management Ltd., a London-based exchange-traded fund provider.

The International Monetary Fund forecasted in October that the average annual inflation rate in advanced economies will double to 1.6 per cent in 2021 from 0.8 per cent last year. Meanwhile, Citigroup Inc. estimates that global inflation will increase to 2.3 per cent this year from last year’s average of 2 per cent.

Recent price developments in commodity markets also suggest inflationary pressures are intensifying.

Brent crude, the international oil benchmark, has surged to more than US$60 a barrel from about US$20 a barrel in late April. J.P. Morgan Chase is forecasting that crude prices could reach US$100 a barrel, a level not reached since 2014.

Copper, the world’s most important industrial metal, has reached an eight-year high above US$8,400 a tonne, up more than 70 per cent from its low last March.

Ugo Montrucchio, head of multi-asset investments for Europe at Schroders PLC, said clients of the £526-billion Britain-based asset manager were asking “more and more questions about inflation.”

“Inflation is at the forefront of the minds of our large institutional clients but less so for retail investors,” Mr. Montrucchio says.

He has been increasing allocations to commodities, U.S. financial stocks and short-term government bonds as hedges against rising inflation.

Policy-makers have signalled that they will not respond to rising inflation by tightening monetary policy until there is clear evidence that the global economy is making a sustainable recovery from the disruption caused by the spread of the novel coronavirus.

Central banks have injected US$6.6-trillion in liquidity into financial markets since March as the pandemic gained pace globally, according to CrossBorder Capital Ltd., a London-based consultancy. It expects central banks to provide at least another US$5.8-trillion in additional liquidity as policy-makers fulfil pledges that they have already made.

“Central banks stand ready to increase liquidity provision beyond what is already in the pipeline, if needed,” said Michael Howell, CEO of CrossBorder Capital.

Rupert Watson, head of asset allocation at Mercer, the consultant, says governments will allow their economies to run hot to aid recovery from the pandemic and that will also push up inflation.

“The global economy is receiving a massive fiscal and monetary boost. We do not expect that inflation will rise as high as 5 per cent, but the risks are changing. We are encouraging clients to think about the inflation sensitivity of their entire portfolios so that they can withstand a range of outcomes,” Mr. Watson says.

The U.S. Federal Reserve Board has indicated that it has no intention of changing its monetary stance until inflation is on track to exceed its 2 per cent target and the jobs market is approaching “maximum employment,” a dual objective that is not expected to be achieved in the near term.

Investors have taken note of the Fed’s guidance and priced in both higher inflation and a robust rebound in economic activity later this year. That has led to the yield on the benchmark U.S. 10-year Treasury bond rising to about 1.3 per cent from 0.72 per cent at the start of September.

U.S. President Joe Biden wants Congress to approve a US$1.9-trillion fiscal stimulus bill in order to accelerate the U.S. economy’s recovery from the COVID-19 pandemic. Republicans oppose Mr. Biden’s plans and Lawrence Summers, who served as Bill Clinton’s Treasury secretary, has warned that the additional spending could trigger “inflationary pressures of a kind we have not seen in a generation.”

In the U.S., headline annual consumer price inflation was running at just 1.4 per cent in January. But recent increases in energy and food prices have driven up inflation expectations among consumers. The University of Michigan published a widely watched survey, which indicates that consumers expect U.S. inflation to reach 3.3 per cent over the next 12 months, the highest reading since 2014.

Lori Heinel, deputy global chief investment officer at Boston-based State Street Global Advisors, the third-largest asset manager in the world, said questions about inflation had been raised by clients in every investor meeting this year.

“The big question that clients want to discuss is whether the stock market could get dragged down by an increase in bond yields as a result of inflation pressures. But history shows that a moderate increase in inflation that is due to stronger economic activity can be good for equities,” Ms. Heinel says.

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